The Consequences of Sanctions on Iran’s Central Bank

Mohammad-Hossein Adeli, former head of Iran's Central Bank.

IRD: Last Monday, in addition to embargoing Iran’s oil, the EU joined the US on imposing sanctions on Iran’s Central Bank. In a dialogue with IRD, Mohammad Hossein Adeli – the former head of Iran’s Central Bank and former ambassador to the UK – outlines the effects of the sanctions on the Central Bank.

Sanction’s Literature

What is known today as ‘economic sanctions’ was recognized as trade war during the 17th and 18th century, with the purpose of economic supremacy and dominance over others. The last series of trade wars (or sanctions) took place from the beginning of the twentieth century to the middle of the Second World War. Afterwards, the world branded itself as civilized, and countries agreed to avoid trade wars as they would result in global economic weakness. Therefore, with the slogan ‘freedom of trade’, the UNCTAD came to existence. The theory of comparative advantage favors free global trade as it benefits all the economies of the world. Competitive advantage, however, was later on added to this theory that stated each country is superior at producing certain products, which could respectively attract investment.

This however does not mean that countries do not use economic means to address disputes. Today, sanctions are usually used for commercial purposes, to maximize interests as well as economic supremacy. One country could use sanctions to score economic control against its opponent. This issue is referred to in the WTO, as this organization condemns such exploits. In such events, both countries could resolve differences with the help of a WTO committee. Such issues, however, do not resolve easily and a hidden trade war could continue.

There are other types of economic war that have political agendas, aimed to create political change in the behavior of the opponent. In sanctions literature this is known as ‘the use of force short of war’. Herman Kahn – the American strategist - uses the ‘Escalation Ladder theory’ to describe this: imposing tough economic sanctions, one after another, is a process that takes place one stage prior to military action by either country in a dispute. The aim here is to inflict economic wounds to weaken a country to a point that the country’s military suffers and it will not be able to perform optimally. Additionally, this will decrease the military costs of the country with the stronger economy.

Iran’s Central Bank’s Immunity

Central banks were not established as governmental bodies and their purpose was to print money and moderate economic balance. Moreover, a person and not a government created the world’s first central bank. For instance, a person founded the Bank of England, which is the world’s second central bank. Although currently governments control central banks, internationally they are recognized as public organizations that belong to the people. Hence, globally central banks benefit from immunity.

The immunity for central banks during various disputes is public consensus. There are two systems regarding the immunity for central banks. Firstly, ‘Absolute Immunity’ grants these banks total immunity as public organizations. Secondly, ‘Restrictive Immunity’ grants immunity based on the activities of the central bank. Both of these models have been invoked in several cases.

The US has the most powerful set of guidelines regarding central banks’ immunity. The Foreign Intelligence Surveillance Act (FISA) grants the strongest of immunities to central banks not only in the US, but also worldwide.

Functions of the Central Bank

Central banks normally have four or five functions. Iran’s Central Bank fulfills all five functions whereas most central banks cover the first four.

The first function of Iran’s Central Bank is enforcing monetary policy by printing and releasing the national currency as well as maintaining and protecting its value internationally.

In return for oil, Iran receives foreign currencies that will then be used as a backing for the Iranian Rial. Without sufficient foreign currency backing, the national inflation rate would reach three, or perhaps even four-digit figures.

The second function of Iran’s Central Bank is forming currency policies, which takes place by a process called ‘Open Market Operations’. This is precisely what Iran’s Central Bank has been doing over the past weeks; to interfere in the foreign currency market to regulate the exchange rates inside the country.

In connection with these two functions, all the central banks around the world have come together to create the International Monetary Fund (IMF), which is the center of the world’s central banks. Iran’s Central Bank’s share of the global free-market funds in the IMF is 1.66%; therefore a sanction on Iran’s Central Bank would result in a theoretical overall slump in the IMF.

The third function of Iran’s Central Bank is reserves management, which keeps account of all the gold and foreign currency in the country.

The forth function of the central bank is monitoring commercial activities, importing sensitive commodities and opening Letters of Credit (LC’s)

The fifth function of Iran’s Central Bank, which is unique to a few countries, is the allocation of oil revenue. This used to be done directly by the central bank whereas now it is an indirect function.

Functions and Immunity Issues

As previously mentioned, central banks are granted immunity yet if the central bank is involved in commercial activities the immunity is reversible, as commercial activities are not public-related services. Some interpret Iran’s oil revenue as a commercial activity. Iran’s Central Bank’s assets, however, should be immune as public property.

The Objectives and effects of Sanctions on Iran’s Central Bank

The first effect of sanctions was to limit the assets of Iran’s Central Bank. The first country to boycott Iran’s Central Bank was the UK, which also acted on freezing its assets, including deposits in foreign accounts. Furthermore, any organization that is in any way related to Iran’s Central Bank is subject to the same sanctions.

Another effect of the sanctions is the potential interference in the Central Bank’s monetary policy. The bank could act on printing money without having the sufficient backing of foreign currency reserves and gold, but it would be an extremely risky move. Printing money without sufficient backing could have catastrophic consequences for the economy.

The final effect of the sanctions on the Central Bank is the blockage of Iran’s oil revenue-- Iran’s largest source of income. Prior to boycotting Iran’s oil, the West acted on imposing sanctions on Iran’s Central Bank. This would cause less harm to the oil market whereas it would paralyze the sanctioned country. By limiting Iran’s banking activities, the West could barter with Iran over oil prices while ensuring Iranian oil is not totally off the market.

Final Words

It seems that by imposing sanctions on Iran’s Central Bank the West is seeking to limit the trading activities of Iran’s oil industry. The US does not have any direct dealings with Iran; therefore it is seeking transnational sanctions on Iran by effectively boycotting any bank that is in trade with Iran’s oil or banking system. During the 90’s, the US attempted to impose transnational sanctions, which did not receive the support of other nations. Today however, other countries are cooperating with the US on sanctions on Iran.

There are alternative ways to escape the current restrictions on Iran, but at greater costs. Furthermore, these sanctions could lead other countries to join in on the sanctions against Iran; yet this will not be an easy process as Iran’s Central Bank is a public organization and therefore protected from sanctions. Iran’s provocations could encourage other countries to go along with imposed sanctions on Iran. Effective diplomacy should be implemented to prevent other countries from joining in on these sanctions.